Ilene Grabel and Ha-Joon Chang
A rising wave of financial protectionism threatens to derail the progress made in improving business entry in emerging markets. As the quote above shows, there is an accelerating trend in favor of capital controls that began with the collapse of the Icelandic economy in 2008. The use of controls in Iceland, explicitly supported by the International Monetary Fund as a way to stem capital flight, has given intellectual cover for policymakers, and emerging markets throughout the world have contemplated or implemented controls:
- In March 2009, Ukraine ordered banks to buy and sell its currency at a rate no weaker than a floor policymakers set each day (with the first day’s floor much higher than the prevailing market rate). This was done ostensibly to prevent the rapid depreciation of the currency from turning into a rout.
- Brazil, which saw its currency appreciate by 36% against the US Dollar in 2009, imposed a 2% tax in October 2009 on money entering the country exclusively for investing in equities and fixed income instruments, doubling the tax to 4% in October 2010.
- Also in late 2009, Taiwan banned foreigners from putting money into time deposits.
- Thailand, following in the footsteps of Chile in the 1990s, enacted a 30% unremunerated reserve requirement in December 2006 on all new inflows. Much as in Taiwan, a further 15% tax on foreigners holding Thai government and state-owned bonds enacted in October 2010 was called a “withholding tax.”
Key results of the study include:
Capital controls have a real and enduring cost for the real economy in countries that enact them, especially at the microeconomic level.
Countries with more open capital accounts fared better in terms of entrepreneurship than those that closed up tight. This result holds for both developed and emerging market economies over the period 2004-08, with firm entry strongly influenced by economic activity, domestic credit availability (for emerging markets), and the availability of foreign capital.
Even as some authors claim that “debilitating neoliberal ideology” removed the leverage for capital controls in emerging markets, Figure 1 shows that this actually has not been the case; a majority of countries have retained some form of control, even through the supposed free-wheeling 1990s, and some have even seen their economic conditions improve while
continuing to have controls.
Given these results, SIEMS concludes that while capital controls may afford a government some “breathing space” for its macroeconomic policies, capital controls have a real and enduring cost for the real economy in countries that enact them. Rather than focusing on building barriers, governments should play the role of facilitator, encouraging entrepreneurship across a broad variety of fronts; this can include traditional innovation policy and investment in R&D. However attention must also be paid to investment climate issues such as capital openness.
More detailed information can be found in SKOLKOVO's survey